Question

Truball Inc., which manufactures sports equipment, consists of several operating divisions. Division A has decided to go outside the company to buy materials since division B plans to increase its selling price for the same materials to $200. Information for division A and division B follows:

Outside price for materials		$195
Division A’s annual purchases		14,500	units
Division B’s variable costs per unit		$185
Division B’s fixed costs, per year	$	1,340,000
Division B’s capacity utilization		100	%

Required:

1. Assume that division B cannot sell its materials to outside buyers. Calculate the net cost or benefit to the company as a whole if Division A purchases the materials outside the company.

2-a. Assume that division B can save $235,000 in fixed costs if it does not manufacture the material for Division A. Calculate the net cost or benefit to the company as a whole for A to purchase outside the company.

2-b. From the standpoint of the effect of the transaction on the company as a whole, should Division A purchase from the outside market?

3-a. Assume the situation in Requirement 1. If the outside market value for the materials drops $12, calculate the net cost or benefit to the company as a whole for A to purchase outside the company.

3-b. From the standpoint of the effect of the transaction on the company as a whole, should Division A purchase from the outside market?

Answer 1

1. Assume that division B cannot sell its materials to outside buyers. Calculate the net cost or benefit to the company as a whole if Division A purchases the materials outside the company.

Answer:

Net Cost to buy Outside

$145,000

Calculation

To find the net cost to buy from outside, we need to find the difference between Purchase Costs from outside and Savings of B's Variable Cost.

Division A purchase decision:

Division A's annual purchases = 14,500

Outside price for materials = 195

Division B's variable costs per unit = 185

Purchase Costs from outside = Division A's annual purchases * Outside price for materials = 14,500 * 195 = 2,827,500

Savings of B's Variable Cost = Division A's annual purchases * Division B's variable costs per unit = 14,500 * 185 = 2,682,500

Net Cost to buy Outside = Purchase Costs from outside - Savings of B's Variable Cost = 2,827,500 - 2,682,500 = 145,000

So the net cost to buy from outside is 145,000

2-a. Assume that division B can save $235,000 in fixed costs if it does not manufacture the material for Division A. Calculate the net cost or benefit to the company as a whole for A to purchase outside the company.

Answer:

Net (Benefit) to Buy Outside

90,000

Calculation

To calculate the net benefit from outside, we need to deduct the Savings of B in fixed costs and Savings of B's Variable Cost from Purchase Costs from outside.

Purchase Costs from outside = Division A's annual purchases * Outside price for materials = 14,500 * 195 = 2,827,500

Savings of B's Variable Cost = Division A's annual purchases * Division B's variable costs per unit = 14,500 * 185 = 2,682,500

Savings of B in fixed costs = 235,000

Net (Benefit) to Buy Outside = Purchase Costs from outside - Savings of B's Variable Cost - Savings of B Material Assignment = 2,827,500 - 2,682,500 - 235,000 = -90,000

So the savings while buying from oustide is 90,000

2-b. From the standpoint of the effect of the transaction on the company as a whole, should Division A purchase from the outside market?

Answer:

Yes

Explanation

Buying from outside will give a benefit of $90,000 for Truball Inc. So from the calculation in Required 2a, it is sure that there is benefit in division B and division A should buy from outside market.

3-a. Assume the situation in Requirement 1. If the outside market value for the materials drops $12, calculate the net cost or benefit to the company as a whole for A to purchase outside the company.

Answer:

Net (Benefit) to Buy Outside

29,000

Calculation
Purchase Costs From Outside = (Outside price for materials - Drop in material outside market value) * Division A's annual purchases = (195 - 12) * 14,500 = 2,653,500

Savings of B's Variable Cost = Division A's annual purchases * Division B's variable costs per unit = 14,500 * 185 = 2,682,500

Net (Benefit) to Buy Outside = Purchase Costs From Outside - Savings of B's Variable Cost = 2,653,500 - 2,682,500 = -29,000

So the savings while buying from oustide is 29,000

3-b. From the standpoint of the effect of the transaction on the company as a whole, should Division A purchase from the outside market?

Answer:

Yes

Explanation

Buying from outside will give a benefit of $29,000 for Truball Inc even though there is $12 drop in outside market value for the materials. So from the calculation in Required 3a, it is sure that there is benefit in division B and division A should buy from outside market.